Tuesday, September 20, 2011

How To Lose $2.3bn

By now, you'll have heard all about Kweku Adoboli, the City trader charged with hiding $2.3bn (£1.46bn) of losses from his bank. You'll have seen the moody black and white photos he posted on Facebook, along with those made-for-tabloid confessional updates such as "Need a miracle". And you'll have read how UBS managers didn't have a clue about the 31-year-old's rogue trading right up until last week.

In the olden, golden days, the most effective way of taking loads of money off a bank was to rob it. Nowadays, if you really want to hit a bank where it hurts, you go and work for it. The Brinks-MAT heist of the early 80s was worth £68m in today's money. The robbery of the Northern Bank headquarters in Belfast in Christmas 2004 netted the equivalent of £31m. Not bad for a day's work, but pocket shrapnel compared with the £4.3bn that Jérôme Kerviel's rogue trading cost Société Générale in 2008, or the £1.2bn of damage (roughly adjusted for inflation) that Nick Leeson did to Barings in the 90s. Besides, rogue trading is a much lower-impact activity than bank robbery, requiring neither balaclavas nor a cosh, but merely some smart slacks and a plausible manner.

The downsides are obvious: get caught and you'll probably get banged up, and never again be allowed within 10 feet of a cash register. On the other hand, your life might become the subject of a film, preferably starring Ewan McGregor trying out his gassy-lager cockney.

Those, briskly rattled off, are the caveats. So, on the strict understanding that you are not actually going to do anything illegal or even vaguely naughty with this information, let me present a five-point guide to rogue trading – or how to lose $2.3bn without your bosses noticing.

First, understand that you don't need to be especially roguish to be a rogue trader. Anyone can do it. Senior bankers don't want to let on, of course, which is why the then-chief executive of France's giant SocGen referred to Kerviel as both an "evil genius" and a "financial terrorist". He was nothing of the sort – just a lowly employee who made a series of big and wrong bets and then covered them up by forging trades, faking emails and making up clients.

Second, come from the wrong background. Stars in a blue-chip finance firm such as SocGen often come with either the right postgraduate degree from the right university – they land in the right departments and stay there, landing the best promotions. They know one patch of one part of their banks – and are blank about the rest, which makes them useless white-collar criminals.

Yet neither Kerviel nor Leeson started out as traders – but in admin positions that taught them how their banks' compliance and other systems worked. It was that knowledge that enabled the two men to go rogue.

Third, read Codes of Finance by Vincent Lepinay. The first in-depth anthropological study of how banks invent new financial products (such as the newfangled derivatives that helped cause the credit crisis), it's really aimed at academics. But would-be rogue traders will find this new book invaluable, as it lays out all the chinks in the modern investment bank. Lepinay spent nearly two years in a huge French bank that he refers to as General Bank, and his study is both highly revealing and slightly farcical.

The press often talks about investment bankers as if they are all one tribe; but as the MIT researcher describes it, there are instead lots of different factions – who have a hard time even understanding each other. The creators of these new derivatives often have top MBAs and look down upon the quant nerds, who deal with prices and have physics degrees. The quants feel superior to the traders, who rely upon them like a tour party relies on its translator. And then there are the salespeople – who just want to flog the things, be they CDOs, CLOs or just plain CRAP. Then there are the risk controllers, who approach the banks' stars with rightful trepidation, and the senior management, who only pop in once a week. What this means for a would-be rogue trader is that there are more gaps in an investment bank's organisation than in the dentistry of the Wife of Bath.

Fourth, work on the most newfangled products, because hardly anyone else will understand what you're up to. Adoboli (who, let me stress, has yet to enter a plea) was in exchange traded funds – which used to look like unit trusts, but have got increasingly complicated. One of the top market regulators, Mario Draghi, recently described ETFs as "reminiscent of what happened in the securitisation market before the crisis". Read that quote again: he's comparing them to sub-prime mortgages. Most of us should get very worried; rogue traders should go steaming in.

Finally, applaud the calls to separate investment wizardy from high-street banking. In finance, the fashionable thing to say is that the UBS scandal proves the Vickers Commission right to call for a ringfence. True, it might protect taxpayers from banking losses, but rogue trading is a product of dysfunctional institutions and the finance sector's love of innovation as a way of skimming off more profits. To have a chance of stopping it, we'll need to make all finance a lot simpler.